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- After a recent stock market decline, investors are reminded of the importance of a balanced investment portfolio.
- Diversification involves spreading investments across different asset classes like stocks, bonds, and real estate to mitigate risk.
- Financial advisors recommend rebalancing portfolios regularly to maintain diversification and capitalize on market fluctuations.
Up until the last few weeks, some investors probably didn’t think much about diversifying. Many were content to let their investment dollars ride on the backs of the “Magnificent Seven” giant technology stocks, which seemingly could only rise in value.
But the recent stock-market stumble, spearheaded by Tesla and other tech giants, serves as a wake-up call that building a balanced investment portfolio should be taken seriously, and revisited at least once a year, if not sooner.
The market stumble, or correction, came swiftly, knocking off more than 10% of the value of the FT Wilshire 5000 Index over three weeks. This broad index tracks more than 3,000 mostly U.S. stocks. Corrections refer to drops of at least 10%, with bear markets defined as declines of 20% or greater.
Prices have bounced back a bit, though the upward momentum appears to have stalled amid rising anxiety over tariffs, lingering inflation issues, federal-workforce layoffs and other issues. Some giant tech stocks stumbled much more severely such as Tesla, which has lost roughly half its value since mid-December.
“The allure of chasing performance led some to evaluate whether diversification had lost its edge in an era dominated by a few unstoppable market leaders,” said Wilshire Associates in a recent commentary. But now, after declines focused on the big tech giants, Wilshire added that investors “who remained patient and adhered to a balanced approach are now realizing the benefits of discipline and diversification.”
How to build a diversified investment portfolio
Diversification is the strategy or process of spreading money among a mix or range of assets with different traits, especially risk levels. Diversifying among stocks means buying companies of different sizes and of varying industries and geographic footprints. It extends to different types of assets entirely, including bonds, real estate, gold, cash or money-market holdings.
Mutual funds and exchange-traded funds often are used, especially to fill gaps where individual stocks or bonds might not be easy to select, such as with foreign markets.
Professionals routinely follow a diversified approach, but it has been easy to ignore with giant tech stocks on such a roll until recently.
“Big tech outperformed just about everything else last year,” said Jenna Biancavilla, principal at Pearl Capital Management in Phoenix. “A lot of people who have written off international (stocks) or bonds aren’t properly diversified.”
Jeff Young, senior wealth manager at Kierland Financial Group in Scottsdale, said he always recommends diversified portfolios for long-term investors. He rebalances once a year, a process that involves subtracting a bit of money from categories that have performed especially well and reinvesting the proceeds in laggards.
Biancavilla said she favors rebalancing every quarter.
The major asset categories Young favors are stocks, bonds, real estate and cash, including funds that own individual securities within those categories. Each of the categories has subgroups, he added.
For example, equities or stocks can be broken down into U.S. or international, large or small, value or growth. The bond or fixed-income category might include government, corporate or tax-free municipal issues.
Real estate can include individual properties, REITS (real estate investment trusts) or funds that hold these assets. “My usual advice is not go to more than 50% (of an investment portfolio) in real estate,” Biancavilla said.
A plan for riding out investment turmoil
Diversified portfolios, with the differing risk and return traits of their individual components, essentially help investors devise a plan to help ride out corrections, like the one that began earlier this year and still might be ongoing.
“Corrections are part and parcel of the investment process, and smart investors understand that,” Young said. “Most successful investors have a plan, and they stay with that plan irrespective of temporary market conditions.”
Investment researcher Morningstar recently analyzed the mutual funds and exchange-traded funds that either created the most wealth or destroyed it over a recent 10-year period.
Morningstar found that nine of the 15 best wealth-creating funds follow indexes and feature low costs, since their managers are not trying to pick individual stocks or bonds. Many of the biggest wealth-destroying funds were those that targeted narrow, specialized or volatile investment categories such as commodities, natural resources or emerging markets.
Morningstar’s definition of value creation or destruction measures total investment returns adjusted for a fund’s size, reflecting the number of investors who hold the fund. “Performance is less meaningful if few shareholders are around to benefit from it,” wrote Morningstar’s Amy Arnott. The two top value-creating funds were Vanguard Total Stock Market Index and Vanguard 500 Index.
For decades, portfolio diversification has been a cornerstone of investment strategy, widely accepted as a time-tested method to mitigate risk and weather market volatility, Wilshire said. But the recent hot streak of a relative handful of high-performing stocks tested the notion.
“We see this moment as a stark illustration of what successful investing demands: not just the foresight to build a diversified portfolio but the discipline to maintain it through market cycles,” Wilshire said. “This recent bout of volatility serves as a reminder of the long-term enduring value proposition of diversification.”
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